Why you might not want to pay off your mortgage
Choosing to become debt-free could change your life. It feels like freedom; it might help you feel at peace knowing you have become 'financially independent.'
Choosing to become debt-free could change your life. It feels like freedom; it might help you feel at peace knowing you have become "financially independent." It's sensible that many people strive to live debt-free, and it's crucial that borrowers with high-interest-rate debt pay off that debt as quickly as possible. However, you often don't need to pay off every debt as quickly as possible. Many people choose to pay down their mortgage at an accelerated rate—but, in fact, it is often best to continue paying your usual mortgage payments and to invest the extra cash. Retiring that debt too soon might actually have the opposite effect you are expecting.
The Power of Leverage
The power of leverage can be quite confusing. If you don't have a strong understanding of the power leverage can have, purposefully choosing to not pay off a debt probably doesn't seem very logical. So, let's make it logical!
For instance; if I offered to give you a $1,000,000 loan at 10% interest to do whatever you wanted with, would you accept? How about a $1,000,000 loan at 3% interest amortized over thirty years? If you reject these loans simply because you feel they would mean taking on too much debt, then you probably categorize every debt as "bad." But, did you consider what you could use that extra money for?
If you took that loan at 3% and invested it all in an index fund that returned the S&P 500 average, over a year you would have accumulated $98,000 dollars in interest while only paying $30,000 in interest on the loan. You are now $68,000 richer than you were when you started! You have successfully learned to use other people's money to generate wealth for yourself.
Paying off your mortgage quicker will reduce overall interest paid on the loan but this savings very rarely comes close to what investing in other areas could generate.
Good Debt and Bad Debt
Interest rates can help determine whether a debt is good or bad. Right now, the risk-free rate of interest for mortgage is lower than the historic average. As long as you stick to your repayment schedule, this is money that can work in your favor.
However, a debt with a high interest rate, like credit card debt, is very different! A horse of a different color.
Let's say you owe $30,000 on a credit card, and you're being charged interest at 15%—if you paid the typical minimum payment, it would take 37 years to pay it off while paying over $37,000 just in interest.
Revolving debts like credit cards carry high rates due to lender risk, whereas mortgages offer lower rates because the home serves as collateral security.
Here are reasons why you might not want to pay off your mortgage
Extra Liquidity
Paying down your mortgage locks your spare cash in one place – that is the opposite of diversification, a critical, longstanding investment principle. Converting liquid cash into home equity by accelerating mortgage payments reduces financial flexibility.
I have a colleague who purchased an expensive Florida home entirely with cash, avoiding any mortgage or lien. However, he failed to obtain windstorm insurance despite living in a hurricane-prone area. When a hurricane struck, the home sustained severe damage.
He could have better deployed his capital by obtaining at least 7% return on his money while securing several other good-quality rental homes using mortgages, keeping other assets protected if disaster struck one property.
High-Interest Debt
If you're repaying other debts (for example, student loans or credit card debt) with higher interest rates than your mortgage, it is almost always the right idea to put your extra cash toward that debt. It makes no financial sense to accelerate mortgage payments at 3% when you're carrying credit card debt at 17%.
To Boost Retirement Savings
You'll require a robust retirement account to maintain a normal standard of living upon retirement. You can pay for a home conveniently at a low interest rate, but you can't pay for your living expenses the same way. Strengthening retirement accounts should take priority over accelerating mortgage payoff, since living expenses in retirement cannot be financed through low-interest borrowing like mortgages can be.
You Don't Really Pay off Your Home
Even after your mortgage is paid off, you still face ongoing expenses: repairs, insurance, taxes, and home association fees. You can even lose your home to tax liens if you did not budget carefully.
Rather than focusing solely on eliminating mortgage debt, consider creating several streams of income via income-producing assets. Multiple revenue sources provide superior financial security compared to the peace of mind from debt elimination alone.
The Bottom Line
The decision to pay off your mortgage early should be weighed against other financial opportunities. In many cases, investing your extra cash rather than accelerating mortgage payments can lead to greater long-term wealth accumulation. Consult with a financial advisor to determine the best strategy for your specific situation.